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Maarten-Jan Bakkum, Senior Emerging Market Strategist, ING Investment Management

Europe earnings to decline by up to 10% as emerging market equities set to outperform developed markets in 2012


In the wake of inflationary pressure, the on-going loosening by China of its monetary policy is likely to be a key catalyst in ensuring the outperformance of emerging market equities compared to developed markets. However, with the crisis in the Eurozone spreading out further towards the core countries in the monetary union, earnings in the region are set to decline by up to 10%, says Maarten-Jan Bakkum (pictured), Senior Emerging Market Strategist, ING Investment Management…

China’s easing of its monetary policy may well be the catalyst for outperformance of emerging market equities versus developed markets. This comes in the wake of moderating inflationary pressures and / or if the Eurozone crisis affects Chinese exports more. We have already seen export growth in Asia in negative territory for three months now.
Total export value in emerging Asia is now 7% lower than in July. In the latest Chinese PMI, new export orders fell below the neutral 50 mark again, suggesting export growth will remain negative in the next few months, perhaps quarters. We strongly believe that the current environment may speed up monetary easing by the Chinese authorities.
Looking to the Eurozone, ING IM observes that the crisis in the Eurozone is spreading out further towards the core countries with the divergence in bond markets also visible in equity markets.  According to the asset manager, UK equities outperformed Eurozone equities by a wide margin year-to-date despite the low domestic growth environment.
For 2012, we estimate a 5 to 10% earnings decline in Europe whereas US companies might be able to escape a comparable earnings decline. This earnings divergence does not come as a surprise. US macro data are holding up relatively well whereas in Europe these surprise on the downside.
However, in our view bottom-up estimates of 9% for US earnings are still too high, andwe estimate US earnings growth 2012 to be slightly negative (between 0% and -3%). All in all, we expect more market weakness in cyclical sectors than in defensive sectors.
Turning to the Eurozone, ING IM recognises that there is fear of a credit crunch. Britain’s banks, for example, have shrunk their interbank lending exposure to peripheral Eurozone countries by a quarter over the last three months to September. With banks in practice having no access to longer-term financing, these fears mount especially as over the next nine months European banks have to refinance EUR500 billion worth of debt.
On the basis of the above, ING IM foresees that a decline in credit commitments is likely. This comes on top of the deleveraging trend in order to comply with stricter capital requirements and a recession in Europe is a given under these circumstances.
Though the picture for Europe is negative, we are not overconfident in the US economy and equity market as shorter term, legislative action needs to be taken in order to extend the payroll tax cut and the unemployment benefits. Failure to deliver, which is not unlikely given the fact that political opponents of Republicans and Democrats are digging in their heels ahead of the Presidential elections, would lead to fiscal tightening of over 1% of GDP and risks pushing the US economy into recession in 2012.
Our concerns about the Eurozone situation and the vulnerability of capital flows to the emerging world are the main reasons that we decided to move to only a small overweight position in emerging market equities. Having said that – and provided the world escapes a systematic crisis caused by a breakup of the Eurozone – we think that the superior fundamentals of emerging markets will be translated into an outperformance. Especially as these markets have a valuation discount. We also expect that the higher earnings growth of emerging market companies will increase the probability of an outperformance.

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